Happy Hour: Wisdom from Ben Graham’s Earliest Writings

August 10, 2018 by Jon

Ben Graham wrote Security Analysis in 1934. The second edition would be published six years later and is heralded as the bible, a beast of a book, on the art of financial analysis. But almost two decades before the first printing of Security Analysis, Graham laid the groundwork for his thought process while writing for The Magazine of Wall Street.

I came across 33 of his articles written from 1917 to 1921 (he wrote for the magazine up till 1927, I believe) and have been reading them over the past two weeks. Combined, they offer some insight into his early investment philosophy, investigative mindset, and process of analyzing companies.

The biggest takeaway is how inconsistent company reporting was back then. There were no rules. The SEC didn’t exist. Graham repeatedly complained about the lack of available information and even goes into detail about how he had to look up war tax records to reverse engineer company earnings.

Another takeaway was his consistency in breaking down the best, worst, and most likely scenarios around a company. He also repeatedly focused on one thing after relating the “story” behind a stock – “Let us see to what extent this opinion is justified by the facts.” Beyond that, was a sense of the impact World War I, and its end, had on companies and the economy.

Rather than diving into the details of each article, I thought I’d share some of the broader wisdom wrapped into his analysis.

The test of the market, like that of Barrie’s policeman, is popularly supposed to be “infallible.” Economists picture a thousand buyers and sellers congregating in the market place to match their keen wits and finally evolve the correct price for each commodity. In the securities market particularly, the word of the ticker is accepted as law, so that one often thinks of prices as determining values, instead of vice-versa. But accurate as markets generally are, they cannot claim infallibility.

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If the paradox be pardoned — for the present the future depends upon the past.

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Only a few years ago the average industrial common stock was little more than a vehicle for speculation. Its market price was determined primarily by manipulation. The only factors of intrinsic worth that received any consideration were current earnings and future prospects. It was taken for granted that the issues had little to no tangible value… But the war has rapidly been transforming these out and out speculations into semi-investment and even pure investment issues.

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This is an excellent opportunity to attack that ancient and deep rooted misconception — namely that a high yield must necessarily signify greater risk than a low yield. As applied to the general run of securities, this rule is obviously true enough — one hundred bonds picked at random from the 4.5% class will eventually be found to include a smaller percentage of defaults than the same number of 6% issues. But with individual securities the case may be very different; and there have been and still are innumerable examples of high yield obligations which are really better protected than many others selling on a lower basis. “Six Percent and Safety” is just as possible as 4% and safety — only it requires greater care and discrimination in selecting the investment.

The fact is that whereas ordinarily a high yield is due to uncertain security, in many particular instances the reason may have no connection with the intrinsic merits of the issue. It is here that the careful investor will find his opportunity and the signs whereby these bargains may be recognized are twofold:
A. Securities safe but unseasoned.
B. Securities safe but affected by investor’s prejudice, never or no longer justified.

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Contrary to general opinion, prices do not always anticipate changed conditions, nor even immediately reflect them. The Law of Inertia holds in finance as everywhere else, and broad intervals often elapse before investors accomodate their judgment to the new order of things.

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The best investment is a good common stock. The stockholder, as a partner in a sound enterprise, may expect not only an attractive return on his capital, but an appreciation in value as the business expands and a surplus accumulates. Many an investor has remarked to the writer, “I never buy stocks. Let the other man speculate. All my money goes into bonds.”

This is perhaps the best policy for those who are unable or unwilling to exercise care in the selection and periodic scrutiny of their investment. But numbers have found to their cost that the word “bond” contained no magic charm guaranteeing against loss — and others as they gained experience have learned conversely that “stocks” do not always signify speculation.

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Real bargains in the industrial list are therefore by no means easy to unearth; careful study — and above all an impartial mind — are required to dig them out.

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The strange revolutions wrought by time are nowhere so evident in the securities market, where an accurate comparison of the present with the past is afforded by the price record over a period of years.

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Wall Street has a beautiful collection of very ancient and often very incorrect traditions.

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Discrepencies — and hence opportunities — in securities originate most often when events move faster than quotations.

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The Street unfortunately is fairly well inured to the bursting of bubbles.

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In the halcyon days of prosperity, the investor is satisfied with increased dividends and a rising market, and cares very little about dry statistics. But in these difficult times the security owner would dearly like to know as frequently as possible just how his enterprise is weathering the storm…